The Blame Game

By Andrew Beattie | May 29, 2009 AAA
The Blame Game

A cynic might state that Wall Street only worries about making money and politicians worry about spending it. When the money quits flowing, however, Wall Street sometimes finds itself called in front of Congress for an investigation. The mortgage meltdown inquisition has been an eye-opener for many people, as it shows how loose Wall Street has been with its risk models. However, for a full account of what has happened, we'd need Congress to put the thumbscrews to itself. (Read more in Who Is To Blame For The Subprime Meltdown?)

Two to Tango
Mortgages and housing are at the heart of the subprime meltdown that has eaten a hole in the world economy, and Wall Street can't take all the blame there. The condemnations of politicians seem hypocritical - after all, the same faces were arguing for affordable housing initiatives and loans for less-than-creditworthy lenders. Politically, giving everyone the means to own a home works because the happy homeowners are more likely to vote in favor of the guy or gal who helped them out. Economically, it doesn't make sense because not everyone will have the personal finances to afford a home.

Lending Without the Guilt
Not so long ago, banks had a good reason to restrict lending only to the most creditworthy. They had to match mortgages to their own debt issues - essentially settling the loan internally - making them very cautious as to whom they lent to because it affected their reserve capital. Enter Freddie and Fannie, quasi-governmental bodies designed to eat up mortgages and spit out securities. Banks, already under pressure to lend to more potential homeowners, now had a buyer for just about every mortgage they cared to make. This incentive to lend was amplified by the Fed keeping interest rates low for an extended period. And lend they did. (Is the U.S. Congress' failure to rein in these mortgage giants to blame for the financial fallout? Read Fannie Mae, Freddie Mac And The Credit Crisis Of 2008.)

Something for Nothing?
People now could buy something despite a credit score of close to zero. Banks came up with all sorts of mortgage innovations – in particular, subprime loans, which used the future home as the collateral – to squeeze even more profits out of the masses. These were also securitized and fed back into the system, sometimes to the very institutions that issued the original mortgages. The financial firms on Wall Street certainly deserve blame for eagerly running to the trough, but it was loose monetary policy and government initiatives that kept the toxic slop flowing.

Hanging Alone
Although they waltzed together happily during the boom, Wall Street quickly found itself without a partner when the music stopped. Droves of new homeowners no longer represented a realization of the American dream brought about by a synergy between business and government. Suddenly all the subprime mortgages were revealed to be speculative and, yes, some were even predatory loans to people who clearly weren't ready to own a home.

So, Wall Street has found itself alone in front of Congress, trying to answer for a situation it didn't cause entirely by itself. Some government officials have admitted that monetary policy and Freddie and Fannie played a role, but far more focus has been given to the shortcomings of Wall Street. Wall Street is paying for its mistakes through the volatile market and the holes in company balance sheets; homeowners are paying for theirs through foreclosure, and it seems like the government is the only party that might not have to face the music. (Read more in How Will The Subprime Mess Impact You?)

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